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Do You Have An Underwater Mortgage? Here Are Your Options

6-minute read

Do you owe more money on your home than your property is worth? If so, you have an underwater mortgage. The situation can be a headache for homeowners – particularly if you want to sell your property or refinance.

We’ll take a closer look at what this means and cover some of the clues that will indicate your mortgage is underwater. We’ll also offer you a few tips so you know how to handle an underwater mortgage and take care of it once and for all. 

Overview: What Is An Underwater Mortgage?

A mortgage is underwater when you owe more money on your home than the home is worth. For example, local property values might fall but you still need to repay the original balance of your loan.

Mortgages aren’t the only loans that can end up underwater. Auto loans, motorcycle loans and boat loans can also go underwater. You may occasionally hear a lender refer to an underwater mortgage as an “upside-down” mortgage.

Let’s look at an example. Say you plan to buy a home for around $200,000. The bank orders an appraisal and the appraiser determines the home is worth $200,000. Satisfied, the bank gives you a loan for $160,000 because you put down $40,000 as a down payment.

A couple years later, you notice that your neighbors are having trouble selling their homes. While the average property value in your area was $200,000 when you bought the home, homeowners in the area have lowered their selling prices to meet the lack of demand. Now, thanks to a decrease in property values, your home is only worth $120,000 and you still owe $155,000 on your mortgage.

Your mortgage can also go underwater when you miss your mortgage payments. Let’s take a look at how that might happen.

The majority of the money you pay goes toward interest when you first start making payments on your loan. As you begin to chip away at your principal loan balance, you pay less and less in interest. This process is called amortization. However, if you fail to pay off your interest one month, that interest will accumulate interest. Compounding interest can make it much more difficult to pay back your loan and may also put you underwater.

Let’s say you borrow $130,000 to buy a home at 4% APR with a 30-year term. On your first payment due date, you owe $620.64. A total of $187.31 goes toward reducing your principal and the remaining $433.33 pays off the interest your loan accumulated since you took it out.

Missing your payment means that the additional amount will also accumulate interest at 4% APR. You’ll go further underwater if you don’t make a payment equal to two monthly payments the very next month. This is why it’s so important to make sure you don’t buy a home you can’t afford.

Underwater mortgages might mean trouble for the following reasons:

Refinancing

You won’t be able to refinance your loan if you’re underwater. Most lenders need you to have some equity in your property before you refinance.

Selling

You might also have difficulty selling your home if your loan is underwater. Most of the time, you use the balance from the sale to pay down your existing mortgage when you sell your home.

But you might not be able to get enough money to cover all your outstanding principal when you’re underwater. This leaves you with only two options: stay in your home and keep making payments or sell the home and cover the rest from your savings.

Potential Of Foreclosure

Underwater mortgages also have a higher chance of going into foreclosure. A foreclosure occurs when you fall too far behind on your payments and the bank seizes your home. You might have no other option than to foreclose if you’re already having trouble making your payments and you can’t refinance.

How To Know If Your Mortgage Is Underwater

Not sure if your mortgage is underwater? Here’s how to know for sure:

Falling Local Property Values

Falling local property values are the first sign that your home may be going underwater. Use a real estate database to check out how much similar homes in your area are selling for. You can also talk to a local real estate expert to learn more about how market prices are trending in your area.

Once you have a good idea of how much local homes are worth, compare it to the remaining principal on your loan. Call your lender and request a “payoff statement” if you’re not sure how much you owe. A payoff statement tells you exactly how much is left on the loan, how much interest you currently owe and the exact date you’re slated to pay it off.

Compare the amount you owe with local property values of similar homes. Is there a major difference between your loan balance and the value of other homes in the area? If so, you’re likely underwater.

Low Appraisal

You can get an independent appraisal if you want a more exact idea of how much your loan is worth. An appraiser looks at the overall condition of the home and how other homes in your area are selling. Getting an appraisal is the most accurate way to understand what your home is worth.

Compare the appraiser’s estimate with the amount you owe on your loan. You’re underwater if the appraiser’s estimate is much lower than your loan balance.

You’re Behind On Your Payments

There’s a good chance that your home is underwater if you’ve fallen behind on your monthly mortgage payments early on in your loan. You can work with your lender to get back on track with your loan and avoid foreclosure if you know that local property values are stable. Contact your lender and request a payoff statement. Compare the amount you owe with the loan amount you took out. You’re underwater if your current principal is higher than it was when you first took out the loan and your home hasn’t gone up in value.

Options For Homeowners If You Have An Underwater Mortgage

Luckily, there are some avenues you can take to change your situation.

Relief Refinance Program

The Freddie Mac Enhanced Relief RefinanceSMprogram is a replacement program for the Home Affordability Refinance Program (HARP) that ended in 2018. An Enhanced Relief RefinanceSMcan help you reduce your mortgage rate or change your interest structure. This type of refinances are only for homeowners who don’t qualify for a standard refinance.

To qualify for the Enhanced Relief RefinanceSM, you’ll need to meet the following standards:

  • Freddie Mac must own your loan.
  • The Note Date of your refinance must be on or after October 1, 2017.
  • You must be current with your loan payments, which means you must have missed no mortgage payments in the last 12 months.
  • You may not have used the HARP to refinance your loan in the past.

Contact your lender to learn more about the next steps and to find out if you qualify for an Enhanced Relief RefinanceSM.

High Loan-To-Value Refinance

Fannie Mae’s version of the Enhanced Relief RefinanceSMis the high loan-to-value (LTV) refinance. The high LTV refinance is similar to the Enhanced Relief RefinanceSMin that it allows you to change the terms of your loan even if you owe more than the home is worth.

Like the Enhanced Relief RefinanceSM, you need to meet a few qualification criteria to apply:

  • Fannie Mae must must own your loan
  • The Note Date of your mortgage must be on or before October 1, 2017.
  • You may not have used the HARP to refinance your loan in the past.
  • You must be current on your loan payments.

Contact your lender to learn more about next steps and to find out whether you qualify for a high LTV refinance.

Summary

An underwater mortgage means that your mortgage has a value that’s more than what the home is worth. Your mortgage loan can go underwater if local home values drop or if you fall behind on your payments. An underwater mortgage may make it impossible to refinance and increase your chances of foreclosure. You can tell if your home is underwater by getting an independent appraisal and comparing the appraisal to what you owe on your loan.

You may qualify for an Enhanced Relief RefinanceSM or a high LTV refinance if your loan is underwater. Both programs are basically the same, but the one you qualify for depends on whether Freddie Mac or Fannie Mae owns your loan. You must be current on your loan payments and not have used the now-defunct Home Affordability Refinance Program (HARP) in the past in order to qualify for either program.

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